If you heard that student loans could not be eliminated through bankruptcy, it is a myth. Technically, you can request bankruptcy discharge on your student loans. However, what makes it hard to get is its prohibitive conditions. Proving a need for bankruptcy is almost impossible. There are still no specific rules on how to prove that you need bankruptcy. Besides, even if you qualify for this option, its negative consequences stay on your credit report for up to 10 years.
This guide explains the details of bankruptcy on student loans. Yet, before you decide to file for bankruptcy, it is advisable to check all your possible options. Hence, we also present you with debt management strategies in case you struggle with debt repayment.
What is Bankruptcy?
Student Loan Bankruptcy helps borrowers in need to wipe out their student loans partially or fully and have a fresh start. It has two main types- Chapter 7 and 13. Each type offers different benefits in terms of your debt and assets. With Chapter 7, you can eliminate debt, but your assets like your house and land can be liquidated. Meanwhile, if you request Chapter 13 bankruptcy, your debt will be reorganized. Instead of eliminating the student debt, the court will create a new repayment strategy for you to pay off the debt. In this case, you can also protect your assets.
Although bankruptcy on student loans should be your last resort, it has some benefits. As mentioned, it can wipe out your debt obligations. Besides, you can stop involuntary collection and pressure from lenders. When you start the bankruptcy process, the court stops creditors from calling, garnishing wages, and filing lawsuits.
Bankruptcy is mostly accessible to borrowers with nonpriority unsecured debt options. These obligations can be credit card debt, medical expenses, overdue utility costs, etc. In these cases, it is easier to file for bankruptcy. Meanwhile, it is harder for borrowers to eliminate their student loans through bankruptcy.
Can You File Bankruptcy on Student Loans?
Technically, yes. You can file bankruptcy on student loans. However, it is almost impossible. What makes bankruptcy hard to achieve is proving an “undue hardship.” This condition indicates that there is no way for you to pay the debt, and if you do, you will not survive. The problem with the condition is that there is no exact rule defining it. Each court can have different rules for hardship.
Besides, if you have a student loan, you most probably have a chance to get a degree. In this case, a borrower with a degree has more probability of finding a decent job in the future, which can help the debtor to repay the debt. Because of this possibility of payment, it is harder to wipe out student loans through bankruptcy.
Yet, there are some criteria used to determine hardship. For example, a Brunner test exists, which requires three main elements from the student loan borrowers. First, you need to prove that if you pay the debt, your current income will not allow you to pay for minimum living standards. Next, you need to show that this financial challenge will continue during most of the repayment period. Lastly, borrowers are obliged to prove that they have good faith. In other words, they tried all other options to pay off the debt before requesting bankruptcy on student loans.
How to Start Bankruptcy?
After considering all your options, you should start the request process if you decide that bankruptcy is the only way out. First, you need to choose between two different types of bankruptcy: Chapter 7 and 13. You should check both options, their requirements, advantages, and disadvantages before deciding. In the following section, we present to you these two types of bankruptcy.
Chapter 7 vs. Chapter 13 Bankruptcy
When people think of bankruptcy, they expect to get rid of the total debt without paying a penny. However, it is not always the case. If you apply for Chapter 7 bankruptcy, sure, you can get rid of the debt. Yet, your debt will be liquidated, meaning that the officials will sell main assets like land, house, or car to pay for your debt. This bankruptcy event will stay in your credit reports for up to 10 years.
On the other hand, Chapter 13 does not eliminate debt completely. This type of bankruptcy is more like restructuring. Instead of canceling your debt, the court will change your repayment plan so that you can pay off some portion of your student loans. As a result, you can even keep your properties. The negative consequences of this bankruptcy can stay on your credit history for up to 10 years.
When to File Bankruptcy?
Although bankruptcy brings many disadvantages, it can be an option in a few cases. For example, if you have already tried all other possible options to pay off the debt, you can file bankruptcy. First, you need to contact your lenders or loan servicing companies to check what you can do to repay the debt. Next, you should be aware of possible repayment, discharge, and forgiveness programs. Finally, if none of these programs work for you, bankruptcy can be the only solution.
Besides, in case your debt obligations are way more than your income, bankruptcy can be unavoidable.
Drawbacks of Bankruptcy
If you want to request bankruptcy on student loans, our advice would be to explore all other options first. Bankruptcy might seem an attractive alternative to borrowers with financial struggles. However, it can bring too many negative consequences. Hence, first, check all your options to repay debt. Then, file for bankruptcy as a last resort.
One of the main negative consequences of bankruptcy on student loans is damaged credit performance. Your credit score will decrease significantly if you request bankruptcy. In addition, the bankruptcy event will stay on your credit reports for up to 7 or 10 years. In this case, you will have difficulty performing simple actions, like qualifying for a new loan, getting a car loan, insurance, apartment for rent, finding an employment opportunity, etc.
Even if you agree with the bad credit history, you may lose your property. As mentioned, Chapter 7 can wipe out your debt obligations, but it can also liquidate your property. You can lose real estate except for the living house, cars, boats, valuable collections, investments, etc.
Lastly, borrowers can feel the emotional impact of filing for bankruptcy. While many would not care about these emotional challenges, others might feel like they lost the student loan battle and might have no hope of having better finances.
Expected Changes to Bankruptcy Rules
Recently, there appeared news that bankruptcy rules will change. As a result, a bankruptcy on student loans can be more accessible. Yet, a lot of questions remain.
Current Bankruptcy Conditions
As mentioned, declaring bankruptcy is hard. If you want an answer to “can you file bankruptcy on student loans?” the answer is yes. However, you will face many challenges, which might make the process almost impossible.
Borrowers should prove an “undue hardship” on their student loans. It means if they pay the student debt, they might not survive with bad finances. Unfortunately, there is no exact rule on what is “undue hardship.” Hence, each case is unique, and each court can create its rules for bankruptcy on student loans.
If you want to prove this hardship, you need to start the process called an adversary proceeding. It means you should sue the lender. These lenders are powerful establishments. In the case of federal loans, the lender is the Education Department. Therefore, they can easily oppose your claims. Besides, lenders have more advantages in the court. As a result, you can lose time and, most importantly money, if you involve legal counsel. The worst part is that if you get paid counsel, it can show the opposite of “undue hardship,” and you might not qualify for bankruptcy.
Expected Changes in Bankruptcy Student Loans
In October 2022, the Federal Student Aid chief operating officer informed Congress that the Education Department is working on improving the conditions for bankruptcy cases. He mentioned that the current rules for bankruptcy on student loans are not acceptable, and the process does not work well.
Therefore, the Education Department is working on new solutions to improve the bankruptcy process. Meanwhile, the advocates recommended the Education Department support the borrowers rather than oppose them. Such a shift could help some borrowers to get bankruptcy on student loans.
Yet, there is still no exact decision on the new rules. However, the FSA’s chief operating officer’s notes create positive expectations from the process.
Legislation for Bankruptcy
Decades ago, the rules for bankruptcy on student loans were different. The “undue hardship” was not required for student loan borrowers, and they did not need to start adversary proceedings. However, in return, it was a requirement to repay the debt for ten years before requesting bankruptcy. This waiting period was necessary to ensure borrowers tried to pay off the debt first instead of immediately eliminating debt through bankruptcy. This rule made getting bankruptcy on student loans as easy as other dischargeable consumer debt.
Currently, a bipartisan group of senators works on the ‘Fresh Start through Bankruptcy’ act. The act aims to change the bankruptcy code so that it is more accessible for student loan borrowers.
Sure, if the Education Department supports bankruptcy rather than opposing it, it can help borrowers. However, its impact on debtors will be moderate. Yet, if the legislation changes, then the impact on student debt can be highly significant.
What about Private Student Loan Debtors?
Unfortunately, the Education Department’s efforts and new reforms like the ‘Fresh Start through Bankruptcy’ act only cover federal student loans. It means, both attempts, if successful, will not help private student loan borrowers. The ‘undue hardship’ is still required for such borrowers. Unless Congress passes legislation that involves private student loans, there is no expectation of improved conditions for bankruptcy on private debt.
Options for Financially Struggling Borrowers
As mentioned before, even if you have financial challenges, you should not rush to request bankruptcy. One of the first options to try can be contacting your loan servicer. Loan servicers are intermediaries between the Education Department and borrowers. They can guide you and make some recommendations. For instance, they can enroll the borrowers with economic hardship in more affordable repayment plans like Income-driven repayment. In short, loan servicers might find solutions for your struggles.
Be Aware of Scams
Borrowers faced with problems in repayment are quick to decide on solutions. They look for ways to get out of the debt desperately, so they can immediately trust the promises. Unfortunately, many borrowers fail to identify scams and believe misleading information. In most cases, the scammers offer debt relief to cope with student loans and require some fees for the assistance. Please, be aware of these scams and stay away from them.
One of the solutions for financially struggling borrowers is requesting loan forbearance or deferment. Both options help to pause repayment for the short term. However, if you apply for forbearance and find a solution to deal with student loans during the non-repayment period, you might not need to request bankruptcy on student loans.
Deferment can happen in specific conditions. For example, you can request a deferment if you are in economic hardship, unemployed, dealing with cancer, rehabilitation from mental issues, alcohol, drug, or providing military service. In some other situations, like if you serve in AmeriCorps, you can get loan forbearance.
However, you need to be careful about the accrued interest during these non-repayment periods. Even if you are not obliged to repay the debt, interest payments can accrue. As a result, the interest payments will be added to the original debt balance when repayment resumes. This process is called capitalization, which is not desirable. Your monthly payments are some percentages of the original debt. If you request forbearance/deferment, your principal debt increases, your monthly payments can also rise.
Enrolling in Income-Driven Repayment
One of the greatest options for borrowers in financial struggles is changing the repayment plan. If you have federal student loans, you have access to multiple repayment options. You can check each option and decide which plan is the most suitable for your finances.
However, in most cases, Income-driven repayment plans are the most affordable ones. These plans are based on income and family size. If you earn less, your monthly payments will also be lower. In extreme cases, you can even qualify for $0 payments.
Besides, Income-driven repayment plans have different types. Each varies depending on the payment rate and period. Plus, there exist differences in eligibility requirements. You can contact your loan servicer to discuss which plan is the best for your challenges.
Additionally, keep in mind that you can qualify for forgiveness through Income-driven repayment plans. Once you complete the payback period, the remaining debt is wiped out.
Refinancing for Private Student Loans
Unfortunately, if you have private student debt, you cannot qualify for Income-driven repayment plans. So, instead of filing bankruptcy on student loans, you need to act fast and find a debt management strategy.
First, you should contact your lender and explain your challenges. Although the lenders have no obligation to help you, they might still appreciate your good faith.
Besides, it can be a good idea to refinance your student loans. Refinancing can help you get lower monthly payments if you find a loan with a lower interest rate. However, this option can also be hard to achieve because refinancing requires good credit performance. So, instead of waiting till you need bankruptcy, act fast and refinance as soon as you are in financial trouble.
Get an Expert Help
Although bankruptcy on student loans can wipe out your debt obligations, it comes with multiple negative consequences. First, its impact on your credit performance can last up to 7 or 10 years. During this time, you will face challenges renting an apartment, finding a job, getting a new loan, etc. Hence, it is advisable to consider all other possible options- repayment plans, forbearance or deferment, forgiveness or discharge programs- before you file for bankruptcy. If you are not sure which option is the best for you, you can contact our debt specialists. Debt experts, like those in Student Loans Resolved, have helped hundreds of borrowers with similar concerns as you have. Experts can analyze your finances and advise the most effective debt resolution strategy. Contact us through free consultation now for a debt-free future.